There are as many ways for seniors to convert a life insurance policy into cash as there are reasons to do it. Economic uncertainty may be one of the reasons that seniors are cashing in their life insurance policies at a growing rate. However, experts have warned that the costs may not justify the benefits.
For Many Seniors, Preventing Policies From Lapsing Is Unavoidable
According to the Life Insurance Settlement Association, nearly 9.3 million policies valued at $624 billion lapse or get surrendered every year.
For some seniors, cashing in a policy may be a preferable alternative to letting it lapse. Yet, many are unaware that this option exists.
Different Categories of Life Insurance Can Be Cashed In
The two general categories of life insurance are term and permanent.
Term life is considered pure insurance because the premiums purchase only a guaranteed death benefit.
Premiums paid on permanent insurance purchase a death benefit and a cash accumulation account that earns tax-deferred income.
Both term and permanent insurance can be converted to cash.
Cashing In vs. Selling a Life Insurance Policy
Term life insurance accumulates no value. It can only be cashed by selling the policy.
Selling a life insurance policy happens in either a viatical settlement or a life settlement.
A viatical settlement is only available to terminally or chronically ill policyholders. A life settlement can be entered into by any policy owner. Neither transaction is taxable.
When a policy is sold, the new owner is obligated to make premium payments and becomes entitled to the policy’s full death benefit.
While a permanent insurance policy can be sold in a viatical or life settlement, there are other options.
Cashing In Permanent Insurance
The cash accumulation account of permanent insurance can be accessed without selling the policy. This can be accomplished in a few ways:
- Borrow from the policy
- Withdraw from the policy
- Surrender the policy
Borrowing From a Policy’s Cash Value
Only a portion of a policy’s cash value can be borrowed, and the loan must be paid back with interest. Interest on an insurance policy loan may be 8% or higher in the current environment.
If the loan is not repaid, its remaining balance will be deducted from the policy’s death benefit.
Interest will continue to accrue on the balance, and if it goes unpaid, the policy could lapse. At that point, the borrowed amount becomes taxable income.
Withdrawing From a Policy’s Cash Value
There are no tax consequences when the cash value of a permanent life insurance policy is withdrawn. Typically, the amount taken out will reduce the death benefit paid when the insured dies.
Surrendering a Policy
Surrendering a life insurance policy means canceling it. The insured receives the cash value, less any fees. Surrender charges can total between 10% and 35%.
Reasons Seniors Cash in Life Insurance
There are some reasons why seniors cash in life insurance policies. Necessity is one of them.
An illness or unexpected economic hardship may be legitimate reasons to cash in an insurance policy. This is especially the case if there are no other liquid assets available.
The U.S. Census Bureau reported in 2022 that fewer than 43% of Americans aged 55 to 64 have sufficient retirement savings to cover monthly expenses. This might make premium payments unaffordable.
For some seniors, cashing in an insurance policy may be the only alternative they have to let it lapse for lack of payment.
Sometimes there is no economic necessity to keep an insurance policy. Cashing in a policy that is no longer wanted or needed may be appropriate.
Financially secure couples whose children are grown and out of the house may not need life insurance. The same is true for widowed seniors.
For others, cashing in a policy to gift a portion of its death benefit to heirs may be more desirable than having them wait for it.
Seniors Should Weigh the Costs and Benefits of Cashing In Life Insurance
Consumer credit reporting agency, Experian, points out that cashing in a life insurance policy at its surrender value nets a consumer between “30% and 50%” of what they have paid in premiums.
The National Association of Insurance Commissioners once noted that “entering into a life settlement agreement is a very poor financial choice for most consumers.”
Selling a life insurance policy can net a consumer less than 20% of the face value of its death benefit. In 2022, nearly $790 million was paid to consumers for life insurance policies representing more than $4.3 billion in face value.
The sales commission on a life settlement can be up to 50% of the price paid for the policy. Still, life settlements grew more than 10% between 2021 and 2022.
Seniors must weigh their immediate need for cash in light of a policy’s future benefits. Those without the luxury of other assets may have no choice but to cash in their life insurance policies.
As with all financial decisions, cashing in a life insurance policy should be considered only after consulting with a trusted and qualified insurance professional.
